Friday, December 3, 2010

MTU Weekend Ed. - Hope Rally Update (12/3/10 Close)

What's new?
The U.S. stock market demonstrated its potential for another year-end rally this week by thrusting 3+% higher after a three-week correction. Moreover, the December SP500 e-mini contract managed to produce a new contract high (above the November high) Friday morning before the disappointing jobs report. Wilshire 5000, Nasdaq composite index made the same achievement towards the end of the day, while Russell 2000 and DJ Transportation index have been ahead of the game for a few days already.

The message from the market might be not to underestimate its near term upside potential.

In hindsight, one might conclude that the U.S. stock market has experienced three policy-induced hope rallies since late 2008/early 2009.

Hope Rally One (HR1) had taken place between late 2008/early 2009 and April 2010, during which the market had been keeping up with quantitative easing zero and one (QE0 and QE1.)

Hope Rally Two (HR2) had taken place between July 2010 and November 2010, during which the market had been front running QE2. It appears that for some officials at least, there had been just too much steam lost after the end of QE1 to propel the economy satisfactorily forward. The idea of a QE2 was then floated, the market extrapolated and the advance was fueled by the good old greed and fear.

Hope Rally Three (HR3) may have started this week. World markets have been tested by renewed sovereign debt concerns in recent weeks and at the same time have witnessed central bankers busy wrapping bail-out packages. There's hope, after all - particularly on a potential up-sized QE2. Even the dismal jobs report Friday could only retain its influence during pre-market hours.

Chart 1 offers a brief time line on quantitative easing and the associated movements in interest rates, USD and stocks.

This weekend update analyzes the wave structure of the current Hope Rally (HR3), as well as the entire Hope Rally since late 2008 / early 2009, and attempts to offer estimated targets. Three times a charm? Chances are good that the entire Hope Rally sees its successful conclusion, at last. See primary counts below.

Probable Structure of Hope Rally Three
Two primary tracking counts of Hope Rally Three are worth noting (Chart 2 and Chart 3). These counts assume that the pullback from the early November high is complete. The black count sees Friday's high in the neighborhood of the end of wave [i]. The green count sees wave [iii] (which is extended itself) already in progress. Please see the final section below for target estimates.

If the correction from the early November high is not complete, this week's advance should be wave [b] of the correction (see the red-labeled count in Chart 2). In this case, the entire correction is more likely to be a minor wave B than a minor wave 4 (see the next section for details), and the market needs to reverse soon.

Probable Structure of the entire Hope Rally

With some prejudice, it would be intuitive if the entire hope rally counts as a triple three, and if need be, a regular five. The subsequent resumption of the bear market or the typically deep wave [2] pullback would then rectify the optimism.

Chart 4 presents two such counts. Objectively speaking, one can justify these two counts based on their own merits without prior prejudice of the larger (fundamental and technical) picture. More over, each of these counts fits into the four long term counts discussed in Let's Recount II (long term)(11/12/10).

The corrective count (red labels) counts the entire hope rally as a triple zigzag and places the market at the early stage of wave C of (Z).

Whether wave B of (Z) has indeed ended this week remains debatable. The market needs to reverse soon if wave B of (Z) were to continue for a few days/weeks. See the red-labeled count in Chart 2.

The motive count (blue labels) counts the entire hope rally as a regular five and places the market at the early stage of wave 5 of (5).

Please see the targets section below for estimates.

Target Estimates
Here are some estimates regarding potential targets for Hope Rally 3 and likely for the entire Hope Rally. The estimation uses text-book style ratio analysis on the two primary counts discussed above, assuming the pullback from the early November high is complete. If the pullback is not complete, we just need to take another look at these targets once the correction is complete.

There are two clusters of potential targets - around 1300 and around 1360 in SP500. Note that the minimum target based on ratio analysis is around 1250. The estimated targets are presented in Chart 5.